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Negotiating the Spirit of the Deal

by David A. Lax and James K. Sebenius 

If you’re an experienced negotiator, you’re likely comfortable with working out the terms of an economic contract—bargaining for the best price, haggling over equity splits, ironing out detailed exit clauses, and so on. In other words, when it comes to the letter of the deal, you’re an expert.

In our experience, though, many seasoned professionals give short shrift to the spirit of the deal, or what we call the social contract. One result is that while the parties can agree to the same terms on paper, they may actually have very different expectations as to how those terms will be met. And because they fail to achieve a true meeting of the minds, the deal they’ve signed may well fall apart. Getting the deal design right calls for getting both the letter and the spirit of the deal right and in sync with each other.

Consider the fate of a joint venture launched by a national hospital organization and a regional health care provider. Executives at these two organizations agreed that at two of their hospitals—geographically very close to each other— the two parties were building redundant facilities and competing for both doctors and patients. In an effort to address this perceived problem, they negotiated a joint venture that would manage the two hospitals and buy or build facilities within the shared market area. The partners created a governance system, appointed managers, and offered management incentives to maximize the venture’s profits, which would then be shared between the parties.

Despite compelling economics, however, the arrangement ultimately dissolved—largely because the partners held different but unspoken assumptions about the joint venture’s purpose. The contract they negotiated, and signed enthusiastically, did not really reflect either partner’s most fundamental objectives.

How can this be? Let’s look at this failure from both sides. Because the national chain had only one hospital in the region, it insisted that the joint venture jointly operate—but not own—the two facilities and it resisted economically sensible steps like eliminating redundant departments, even though such actions were consistent with the joint venture’s formal contract and management incentives. The national chain was concerned that the joint venture might fail one day. If it did, the chain’s hospital—offering only reduced services—would no longer be competitive.

Executives at the regional chain, by contrast, saw the joint venture in another light: as a way to extend their regional network. They consistently sought to optimize the efficiency of their overall network (including the national chain’s hospital), but the formal contract and management incentives—to maximize stand-alone joint venture profits—conflicted with that goal.

Had the parties better understood each other’s views of the underlying purpose of the venture, they might have forged a more limited, and more effective, agreement. Such a deal would have ignored possible operating efficiencies, and focused on gains from jointly buying practices and building shared feeder facilities in their common market area. As it happened, a clash of underlying expectations and a contract inconsistent with either set of expectations transformed enthusiasm and potential profits into a swamp of recriminations.

Based on our participation in and study of hundreds of negotiations, along with a growing number of academic studies of contracts, we believe that cultivating a shared understanding of the spirit of the deal—the social contract— can be every bit as important as coming to agreement on the letter of the deal. The term social contract, evoking the writings of Locke and Rousseau, has a grand sweep and far-ranging political connotations. We use the concept in a much more limited way, to mean the expectations held by two or more negotiating parties about their agreement.

These social contract expectations operate on two levels: The underlying social contract answers the question “what?” For instance, are we working out a series of discrete transactions or a real partnership? An acquisition or a merger of equals? What is the real nature and duration of our agreement? The ongoing social contract, by contrast, answers the question “how?” How will we make decisions, handle unforeseen events, communicate, resolve disputes? 

By examining the two types of social contracts and taking a hard look at the problems that arise when social and economic contracts are at odds with each other, the 3D negotiator can find ways to keep the contracts independently strong and mutually reinforcing.

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David A. Lax and James K. Sebenius are the authors of 3D Negotiation – Powerful Tools to Change the Game in Your Most Important Deals (Harvard Business School Press, September 2006). For more information see their book website www.3dnegotiation.com and their business website www.negotiate.com.  

Adapted with permission from Harvard Business School Press from 3-D Negotiation: Powerful Tools to Change the Game in Your Most Important Deals by David A. Lax and James K. Sebenius. Copyright 2006 David A. Lax and James K. Sebenius. All Rights Reserved.

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